Small business deduction denied
A Canadian-controlled private corporation (CCPC) can claim the small business deduction to reduce its federal tax rate from the general 15% rate to 10.5%. The corresponding provincial rate is also reduced. However, the federal small business deduction applies only to the first $500,000 of active business income per year (with adjustments in certain cases).
For these purposes, active business income of a corporation does not include income from a “specified investment business”, which generally means a business carried on by the corporation, the principal purpose of which is to derive income from property such as interest, dividends, rents and royalties. There are a couple of exceptions – for example, if the corporation employs more than five full-time employees throughout the relevant year, the business will not be a specified investment business, meaning that the business income can qualify for the small business deduction.
In the recent Skartaris Holdings case, the corporation was a CCPC that purchased eleven houses over a 10-year period. The main shareholder of the corporation stated that the business of the corporation involved the purchase of properties with a view of renovating them and selling them at a profit. As such, he took the position that it carried on an active business and could claim the small business deduction.
However, until the properties were sold, they were rented out, so the corporation earned rental income. In fact, in the two taxation years that were at issue, all of the corporation’s revenues were earned from renting out the properties and none from the sale of properties. The CRA assessed the corporation to deny the small business deduction on the grounds that it carried on a specified investment business in those two years.
On the taxpayer’s appeal to the Tax Court of Canada, the Court upheld the CRA decision. Basically, the Court held that the documentary evidence at hand did not support the taxpayer’s position that it was in the business of buying and selling properties, and the shareholder’s stated purpose was not backed up by the facts. Accordingly, its main business was earning rental income, and it did not have more than five-full time employees. Therefore, it was carrying on a “specified investment business” and the small business deduction was denied.